Minneapolis Fed bank head talks to Rotary

More stimulus may mean less unemployment

September 27, 2013

HOUGHTON - Continuing, or even boosting, stimulus to reduce unemployment should be the Federal Reserve's top priority, the head of the Minneapolis bank told a lunchtime crowd in Houghton Thursday.

Narayana Kocherlakota said while the unemployment rate has rebounded somewhat from its low of 10 percent in October 2009, the 7.3 percent rate is still "unusually high" relative to the last quarter-century. And most of that decline comes from people who have stopped looking for work, Kocherlakota said.

"The weak labor market represents considerable hardship for a large number of Americans, both in economic terms and in psychological terms," he told the Houghton Rotary Club at its monthly meeting. "Second, it represents a significant waste of resources for the national economy, because our country's failing to use a large fraction of our given potential. For both of those reasons, I believe that those of us who are charged with making economic policy should do whatever we can to facilitate a faster rate of improvement in labor market conditions."

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Kocherlakota disputed the notion that monetary policy won't be effective in addressing the labor market. Personal consumption expenditures (PCE) inflation is expected to remain below 2 percent through 2018, which he said would give monetary policy room to improve the labor market.

Kocherlakota took his speech's title "A Time of Testing" from one former Fed Chair Paul Volcker gave in 1979. Volcker called for the Fed to take strong measures to reduce inflation. The Fed followed that policy and stuck to it, despite unemployment and interest rates reaching post-World War II highs. By 1983, inflation had declined from 9 percent at the time of Volcker's speech to 4 percent.

Kocherlakota sees several parallels to 1979: A stubborn problem, and a widespread perception that the central bank can't or won't solve the problem. And that view complicates things further, he said.

"If households expect their incomes to be low in the future, they will save more and spend less," he said. "If businesses expect low future demand for their products, they will invest less today and hire fewer people today."

Through a goal-oriented policy, the Fed could tell the public where it is taking the economy, which would be reinforced by future actions.

Last week the Fed announced it would continue to buy $85 billion a month in long-term bonds, surprising many observers who expected the Fed to begin slowly reducing the stimulus. Kocherlakota said the direct economic impact would be small either way. The most significant thing about the move might be the outsized impact the news had, which he said reinforces the need for better communication from the Fed.

"I think we have to enhance our communication, be more comprehensive in our communication, so that people don't have those uncertainties," he said in an interview before the meeting. "As long as they do, even these small changes in stance of policy are going to be seen as having undue content, undue signal."

The FOMC should do "whatever it takes" to increase employment over the next few years, continuing its unconventional monetary policy tools, Kocherlakota said. The Fed should continue - or increase - stimulus even as interest rates remain historically low, per capita employment rises, economic growth becomes higher than average, asset prices become high enough to raise concerns about bubbles and medium-term inflation outlook temporarily passes 2 percent.

"It may not be able to stick to this path providing a high level of monetary accommodation even as these conditions I've described materialize, but I anticipate that the benefits of doing so, in terms of employment gains, will be significant," he said.

The Federal Reserve may soon have a new leader, as current Chair Ben Bernanke's term ends in January. Kocherlakota said he has "enormous respect" and admiration for Vice Chairwoman of the Board of Governors Janet Yellen, considered the front runner, but that there are a number qualified candidates.

Asked about what he'd like to see in a chair, Kocherlakota said he sees it less in terms of people than policy. Congress has established a dual mandate for the Federal Open Market Committee of keeping inflation around 2 percent and keeping unemployment low.

"It's really about choosing leadership for the committee that will do the most effective job of meeting our goals," he said in an interview before the meeting. "That's the kind of people they should be putting in place. I think a wide range of characteristics is going to be able to achieve that, but more it's about having the vision for achieving those goals."